United States: Massachusetts Appellate Tax Board Holds No Bona Fide Debt In Related-Party Transaction

The Massachusetts Appellate Tax Board has held that related-party transactions which occurred as part of a cash management system did not give rise to bona fide debt.1 Therefore, the amounts a taxpayer advanced to its subsidiaries pursuant to these transactions did not qualify as debt for purposes of the net income portion or the net worth portion of the Massachusetts corporate excise tax.


Staples, Inc. (Staples) is headquartered in Massachusetts and, through its wholly-owned subsidiaries, is a wholesale and retail distributor of office supplies. Staples managed the cash generated by its domestic subsidiaries on a centralized basis through a cash management system (CMS) generally described as a "cash sweep." Staples' subsidiaries maintained zero-balance accounts, as cash generated by each subsidiary's operations was "swept" on a nightly basis into a common bank account maintained by Staples. Affiliated entity expenses, such as invoices from vendors, payroll, third-party professional service providers, utilities, and rent, were paid from this common account. If expenses paid on behalf of a particular subsidiary exceeded that subsidiary's cash contribution from its operations, the subsidiary was in a net payable position. Conversely, if a subsidiary had contributed more than its share of expenses, it was in a net receivable position.2

Staples entered into written agreements with CMS participants, including Staples Contract & Commercial, Inc. (SCC), which stated that each subsidiary would execute a note in favor of Staples for $75 million, and Staples would execute a promissory note in favor of each subsidiary for the same amount.3 In fact, several promissory notes including interest and repayment terms were executed by Staples in favor of its subsidiaries, including a note with Staples West for $75 million, SCC for $100 million and Staples East for $200 million. No corresponding demand notes were executed and no invoices requesting payment of principal and/or interest were produced. Aside from bookkeeping entries recording amounts generally characterized as due to or due from Staples, no evidence of payments on the notes was offered. The actual balances due from Staples to its subsidiaries, including SCC, significantly exceeded the stated limits in the notes.4

For the tax years ended January 31, 2002 through January 31, 2005, Staples filed a Form 355C, Combined Massachusetts Corporate Excise Tax Return, as the principal reporting corporation for a combined group of affiliated entities including SCC. On the returns, Staples deducted amounts characterized as interest paid with respect to the amounts owed to its subsidiaries in computing the income tax portion of the excise tax. Staples' subsidiaries, including SCC, deducted the CMS balances in computing their non-income measure of the tax. In 2010, the Commissioner issued Notices of Assessment to Staples and SCC assessing corporate excise, interest and penalties based on the notion that the transactions giving rise to the balances did not constitute bona fide debt for Massachusetts corporate excise tax purposes, and therefore the amounts were not deductible under both the income and non-income measures of the tax. The Commissioner was deemed to deny the taxpayers' applications for abatement, and the taxpayers timely filed appeals with the Board in March 2011.

Intercompany Transactions Were Not Bona Fide Debt

Income Portion of Tax

Pursuant to Massachusetts law, a corporation's net income generally consists of gross income less certain allowable deductions under the Internal Revenue Code, including a deduction for "all interest paid or accrued within the taxable year on indebtedness."5 For a transaction to give rise to a valid interest deduction for federal income tax purposes, the transaction must constitute true indebtedness.6 Specifically, true indebtedness requires "an unconditional obligation on the part of the transferee to repay the money, and an unconditional intention on the part of the transferor to secure repayment."7 True indebtedness can become an issue when transactions are made between related entities. The Board noted that "related but separate entities can freely enter into contracts including debt transactions,"8 and that courts will examine such transactions with greater scrutiny because the transactions may not "result from arm's length bargaining."9

Although the issue of whether transfers between related entities constitute debt has been litigated often, courts have not established a bright-line rule for making such a determination. Instead, the specific facts and circumstances of a particular case are examined to determine if intercompany transactions constitute true indebtedness. In New York Times Sales, Inc. v. Commissioner of Revenue,10 the Massachusetts Appeals Court provided the following factors in concluding that related-party intercompany cash transactions were dividends, not loans:

  • The amounts transferred were not limited in any manner;
  • There was no repayment schedule and no fixed dates of maturity;
  • The amounts transferred from the subsidiary to the parent were intended to remain with the parent for use in fulfilling its various corporate purposes;
  • No interest was charged;
  • No notes or other evidences of indebtedness existed;
  • The transferred cash was not secured in any manner;
  • The subsidiary never requested repayment;
  • There was no evidence that the subsidiary had any expectations of repayment; and
  • The parent did not make any effort to repay the amounts transferred to it by its subsidiary.11

In this instance, the Board followed a strikingly similar analysis, mirroring its action in a previous decision cited as reference.12 Specifically, the Board considered each of these factors and found that as a whole, they weighed heavily against the taxpayer. To begin, the amounts transferred to Staples under the CMS were not limited in any manner. Instead, the operating subsidiaries deposited all of their revenue into their zerobalance accounts, from which the deposits were swept daily into Staples' cash account.

Further, there were no repayment schedules, no history of repayments, and no other evidence indicating that there was any actual repayment or intent to repay the excess cash retained by Staples. Because Staples retained cash advances net of the subsidiaries' expenses indefinitely, the excess cash transfers were permanent in nature and not intended to be repaid.

While payments of interest and principal were referenced in the notes, no amounts were ever actually paid to Staples' operating subsidiaries. Instead, only bookkeeping entries of interest were made. Moreover, even though the supposed indebtedness of Staples was evidenced by written notes, its wholly-owned subsidiaries lacked control to enforce payment by their parent company, which made no payments on the purported debts. The Board also found that repayment of the supposed debt was not secured in any way. The Board specifically rejected comparison of the cash sweep into Staples' account to a bank deposit account, noting that a bank is "legally bound to return deposits as well as accumulated interest to its customers, and absent anomalous circumstances, does so."13

Addressing the remaining factors indicative of the absence of bona fide debt, the Board found that there was no evidence that the operating subsidiaries ever requested or had the expectation of repayment, and that Staples never made an effort to repay the operating subsidiaries pursuant to the terms of the notes. Instead, the net accounts-payable balances were unlimited, always growing and never repaid, and no evidence was presented that the subsidiaries had any control over the amounts advanced or any settlement procedures in place to ensure the repayment of the excess cash and accrued interest to the subsidiaries. Thus, the Board determined that the intercompany transfers associated with Staples' CMS did not give rise to bona fide debt. As a result, the related interest was not deductible.

Non-Income Portion of Tax

The non-income portion of the Massachusetts corporate excise tax is generally assessed on the net worth of a corporation. Specifically, net worth is computed based on the book value of a corporation's total assets reduced by its liabilities and other specific deductions.14

Staples and its subsidiaries contended that the transfers of cash between entities associated with the CMS were debt for purposes of the non-income portion of the tax. Specifically, Staples referenced previous cases as supportive of its contention that the Commissioner was bound in computing net worth to be consistent with principles of accounting that are actually employed by the taxpayer.15 Rejecting this contention, the Board cited previous rejections of the notion that a taxpayer's books and records should be controlling for tax purposes.16 The Board found nothing in the cited cases to support Staples' proposition that incorrect characterization of the debt accounts in its books and records should yield its desired net worth tax treatment. To conclude otherwise, the Board noted, would "allow a taxpayer to achieve desired tax results simply by presenting financial statements crafted to support such results." Thus, the Board found that the excess cash advances to Staples from its wholly-owned subsidiaries pursuant to the CMS were not bona fide debt for purposes of the net worth portion of the corporate excise tax.

Addback Requirement Not Relevant

For tax years beginning on or after January 1, 2002, Massachusetts law generally requires a taxpayer to add back otherwise deductible interest expenses and costs directly or indirectly paid, accrued or incurred to a related party.17 However, otherwise deductible interest paid to a related party is deductible if the taxpayer establishes by "clear and convincing evidence" that disallowance of the deduction would be unreasonable.18

Following the determination that the transactions at issue did not qualify as bona fide debt, the Board held that it need not consider applicability of the addback requirement in this instance. As Staples did not have bona fide debt, no deductible interest was present. Thus, the addback requirement did not apply.


Since the advent of mandatory unitary combined reporting for the 2009 tax year in Massachusetts, the focus of intercompany transactions and their effect on excise tax liability generally has moved away the application of the related-party addback rules to the mechanics of the combined report itself. However, related-party transactions and the related-party expense addback rules are still in effect and do come into play from time to time.19 The Board's ruling in this case distinctly contrasts with its recent ruling allowing a taxpayer to claim an exception to the related-party interest addback rule based on the determination that its application was unreasonable under the circumstances.20 As illustrated by that decision, a taxpayer with appropriate facts can successfully support a conclusion that bona fide debt exists. Only if a taxpayer is able to prove that its loans constitute bona fide debt will the Board consider the requirements for the exception from the related-party interest addback requirement.

Similar to the Board's decision in Sysco, this decision emphasizes the importance of the factors in the New York Times Sales case in determining whether or not intercompany transactions constitute bona fide debt. For two related parties to report interest income and claim a corresponding interest deduction, the parties must clearly intend to create true indebtedness, and an ultimate expectation of repayment must exist. Evidence supporting this contention, such as cash payments of interest and principal, is crucial to prove intent, even if the transaction has a valid business purpose. Taxpayers engaged in transactions with related entities should consider the presence of the listed factors, especially with respect to any Massachusetts excise tax returns filed on a separate entity basis. In the realm of combined reporting in Massachusetts, consideration of whether bona fide debt exists could also prove relevant in related party transactions between a member and nonmember of a Massachusetts combined group. Although market forces would likely serve to prevent the existence of most of these factors in third-party transactions, taxpayers should maintain a general awareness of the factors indicative of bona fide debt for tax purposes.


1 Staples, Inc. v. Commissioner of Revenue; Staples Contract & Commercial, Inc. v. Commissioner of Revenue, Massachusetts Appellate Tax Board, Nos. C310640, C310639, Sep. 4, 2015.

2 Note that the Staples' books and records used for financial accounting purposes were presented on a consolidated basis and therefore reflected only transactions with third parties.

3 Other wholly-owned subsidiaries which participated in the CMS included: (i) Staples East; (ii) Staples West (through Jan. 31, 2004); (iii) Staples the Office Superstore, LLC (beginning Feb. 1, 2004); (iv) Staples the Office Superstore, LP (beginning Feb. 1, 2004); (v) SCC; (vi) Quill Corporation; (vii) Quill Lincolnshire, Inc. (beginning Feb. 1, 2004); (viii) Medical Arts Press, Inc. (beginning July 17, 2002); and (ix) Smilemakers, Inc. (beginning July 17, 2002).

4 Staples' net intercompany accounts payable balances, which reflected actual cash retained by Staples after payment of the subsidiaries' expenses, were: (i) for the tax year ended Jan. 31, 2002, $982,926,259; (ii) for the tax year ended Jan. 31, 2003, $1,628,952,510; for the tax year ended Jan. 31, 2004, $2,180,252,438; and (iv) for the tax year ended Jan. 31, 2005, $2,411,618,446.

5 See MASS. GEN. LAWS ch. 63, § 30(4); IRC § 163(a).

6 See Knetsch v. United States, 364 U.S. 361, 364-65 (1960).

7 Schering-Plough Corp. v. United States, 651 F. Supp. 2d 219, 244 (D.N.J. 2009) (quoting Geftman v. Commissioner of Internal Revenue, 154 F.3d 61, 68 (3rd Cir. 1998)).

8 Overnite Transportation Co. v. Commissioner of Revenue, 764 N.E.2d 363 (Mass. App. Ct. 2002) (citing Bordo Products Co. v. United States, 476 F.2d 1312, 1323 (Ct. Cl. 1973)).

9 Id. (citing Kraft Foods Co. v. Commissioner, 232 F.2d. 118, 123-24 (2nd Cir. 1968)).

10 667 N.E.2d 302 (Mass. App. Ct. 1996).

11 Id.

12 Sysco Corp. v. Commissioner of Revenue, Massachusetts Appellate Tax Board, Nos. C282656, C283182, Oct. 11, 2011, aff'd, 986 N.E.2d 895 (Mass. App. Ct. 2013), review denied, 990 N.E.2d 562 (Mass. 2013). See GT SALT Alert: Massachusetts ATB Upholds Disallowance of Interest Deduction.

13 Id.

14 MASS. GEN. LAWS ch. 63, § 30(8); MASS. REGS. CODE tit. 830, § 63.30.1.

15 Citing Xtra, Inc. v. Commissioner, 402 N.E.2d 1324 (Mass. 1980) and National Amusements, Inc. v. Commissioner, Massachusetts Appellate Tax Board, No. F251216 (2001).

16 New York Times Sales, Inc. v. Commissioner, 667 N.E.2d 302 (Mass. App. Ct. 1996); Overnite Transportation Co. v. Commissioner of Revenue, 764 N.E.2d 363 (Mass. App. Ct. 2002); and National Grid USA Service Co. v. Commissioner, Massachusetts Appellate Tax Board, Nos. C292287, C292288, and C292289, June 4, 2014.

17 MASS. GEN. LAWS ch. 63, § 31I(b).

18 MASS. GEN. LAWS ch. 63, §§ 31I(c)(i); 31J(a).

19 See MASS. GEN. LAWS ch. 63, § 32B(c)(3)(iv), (f), which effectively allows for the adjustments under the Massachusetts related-party expense addback rules in the combined reporting context.

20 Massachusetts Mutual Life Insurance Co. v. Commissioner of Revenue, Massachusetts Appellate Tax Board, Nos. C305276, C305277, June 12, 2015.

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